What Is It?
Before 1917, Congress was required to approve each issuance of debt with a separate piece of
legislation. This changed in 1917 when the Second Liberty Bonds Act was passed. This Act was
designed to simplify the process and issuance of new debt by creating a “debt ceiling” – a cap
on the amount of new debt the Treasury could issue. Once this ceiling is reached, the Treasury
can no longer issue new debt to meet its obligations.
What Happened on January 19th?
On Thursday, January 19th, the U.S. national debt topped the $31.4 trillion threshold set by
Congress.
Treasury Secretary Janet Yellen notified congressional leaders that the U.S. Treasury would
begin “extraordinary measures” to keep the U.S. government from defaulting on its debt,
asking for a raise or suspension of the debt limit.
These extraordinary measures are expected to push out the “deadline” (or “X-date”) to
sometime in June, although the Treasury could potentially employ additional maneuvers to buy
some added time.
Ultimately however, the debt ceiling will need to be raised or suspended.
What Happens in a Default?
As the U.S. has never defaulted on its obligations, the ultimate ramifications are something of
an uncertainty.
However, in short, a default would result in chaos in both the domestic and global financial
markets. Concern about the Federal Reserve’s “soft” versus “hard” landing with regards to a
recession would be secondary. Interest rates would rise while demand for Treasuries would
drop. Rising interest rates would trigger higher rates on consumer debt as well, while at the
same time a tightening of credit may ripple throughout the economy. Social Security, Medicare,
and military wages could all be impacted.
What Happens Next?
The next few months will consist of intense negotiation. The main question is what will either a
suspension or increase in the debt ceiling be accompanied with.
House GOP members are looking for federal spending cuts while the White House is insisting it
be passed without conditions (a similar impasse occurred in 2011 between GOP and the Obama
administration; the fallout of which saw the U.S. suffering its first ever credit downgrade). While
past performance is not indicative of future results, some comfort may be brought by the U.S.’s
long track record of fulfilling its obligations. In addition, both parties are adamant that a default
is out of the question. Time will tell.
Sources:
1. https://www.nytimes.com/2023/01/19/us/politics/debt-limit-economy.html
2. https://www.crfb.org/papers/qa-everything-you-should-know-about-debt-ceiling#what
3. https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/debtlimit
4. https://www.nbcnews.com/politics/congress/debt-ceiling-deadline-biden-negotiate-2011-near-defaultrcna67854
5. https://www.washingtonpost.com/politics/2023/01/29/kevin-mccarthy-debt-ceiling/